When you have a spending goal, whether big or small, you need to plan around how that goal will be funded. Will the goal be funded via cash flow or cash on hand? Will you need to sell assets and/or take on debt? Where you are in your stage of life has a big impact on the decision too- Are you still working or are you retired? Everyone has different levels of comfort when it comes to debt which should be considered.
Given where inflation and interest rates are today, this environment presents complex challenges that may have a positive or negative impact on new or existing debt.
They say a dollar today is worth more than a dollar tomorrow. This is especially true in an inflationary environment, as you lose purchasing power over time. What does that mean for your debt? Inflation reduces the real value of existing debt. This makes healthy debt more attractive from a long-term perspective because you’re able to pay down debt dollar for dollar, even though on a relative basis your dollar is worth less.
Interest rates have surged in 2022, as a direct result of the Federal Reserve increasing the Federal Funds Rate to fight inflation. These rate hikes have had a major impact on the cost of borrowing, increasing the cost of existing adjustable rate or new debt. If you have a fixed rate mortgage that you’ve refinanced or taken out over the past 10 years or so, you’re probably in good shape as you’ve locked in a rate lower than today’s averages. If you have adjustable-rate debt or are looking to take on new debt at a higher rate, there is a break-even analysis that should be considered.
When leveraging an asset and borrowing against it, you can perform a break-even analysis to compare the rate of interest you’ll be charged versus an expected rate of return on the asset. Broadly speaking, almost any asset can be leveraged such as; real estate, investment portfolios, or vehicles. Over long periods of time, real estate and investments will generally increase in value while most vehicles will typically decrease in value.
Home equity lines of credit and mortgages are tools that can be used to tap a portion of your home equity. A more stable asset like real estate, can provide more predictability and peace of mind to manage the debt.
A portfolio line of credit and margin are tools that can be used into the value of an investment account. Leveraging a more volatile asset such as stock, can be very uncomfortable and risky if you don’t watch it closely. Declines in stock portfolios can trigger a margin call at very inopportune times. To help protect against margin calls, it is prudent to leave a cushion that protects you from a sudden drop in value of your collateral.
After deciding on an asset to leverage, you’ll want to evaluate the interest rate environment relative to your timeframe of borrowing. These factors will have an impact on your decision to borrow on an adjustable or fixed interest rate.
If you are considering a purchase and want to explore leveraging an asset, reach out to your wealth advisor to see what options are available to you and what implications this may have on your financial plan.
Important disclosure information
Please remember that different types of investments involve varying degrees of risk, including the loss of money invested. Past performance may not be indicative of future results. Therefore, it should not be assumed that future performance of any specific investment or investment strategy, including the investments or investment strategies recommended or undertaken by RegentAtlantic Capital, LLC (“RegentAtlantic”) will be profitable.
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This article is not a substitute for personalized advice from RegentAtlantic. This article is current only as of the date on which it was sent. The statements and opinions expressed are, however, subject to change without notice based on market and other conditions and may differ from opinions expressed in other businesses and activities of RegentAtlantic. Descriptions of RegentAtlantic’s process and strategies are based on general practice and we may make exceptions in specific cases.
RegentAtlantic does not provide legal or tax advice. Please consult with a legal and or tax professional of your choosing prior to implementing any of the strategies discussed in this article.